What is Your Business Worth?

When a business owner thinks about selling his business, one of the first questions he asks both himself and the individuals who advise him is, “What will someone pay me to buy my company?” 

Most business owners want a concrete number or at least a range of value so that they can set their own expectations and judge whether or not they would sell their business for that amount. However, there are no analytic formulas that can determine valuation. Rather these formulas are guidelines for approximate value. Realistically, your business is worth what a buyer will pay. There are, however, various factors that can affect valuation. Understanding these variables can help you improve your business’ performance, understand the thought process of a potential buyer, and better negotiate a sale. 

When you hear or read about purchase prices paid for companies, it is usually in the context of a multiple of revenues such as two times a full year’s revenue or EBITDA (earnings before interest, taxes, depreciation and amortization; a stand-in for cash flow). The revenues and EBITDA are usually based on pro-forma income statements, which are statements prepared as if the companies were operating on a stand-alone basis with one-time revenues and costs excluded. In privately owned businesses, personal expenses are excluded from the statements and market compensation is added back in. The multiple that is paid, if the purchase price is paid in cash at closing, is the purchase price divided by the revenues or divided by EBITDA. However, these multiples are affected by the following factors: 

Economic Environment 

It is general knowledge that multiples prior to the 2008 crash were higher compared to those at the end of 2009. This downward direction reflects the current general economic malaise and buyers’ appetite to pay less, even though it has been reported that many public companies are sitting on a lot of cash. The current economic environment presents a great opportunity for them to purchase companies at lower multiples. Multiples paid by financial buyers, such as private equity firms, have also decreased because of the scarcity of financing. 

Industry Sectors 

Different industry sectors command different multiples for many reasons (different growth rates, performance, appeal, etc). For example, average revenue multiples for recent transactions in the consulting, advertising, and digital media sectors were 0.8×, 1× and 1.5×, respectively. We could attribute this to business model differences regarding recurring revenue; but while that’s relevant, it does not really explain the multiple disparity. You might want to begin collecting transaction information about deals occurring in your industry so that you have a basis of comparison. 

Business Models 

Recurring revenue, such as subscription revenue, commands a higher multiple than revenue that has to be resold each time, such as consulting revenue. Revenues from multi-year contracts command higher multiples than revenue from unit sales. Companies offering continuing legal education for lawyers are worth more to strategic buyers than companies offering continuing professional education for accountants because the marketplace for services offered to lawyers is larger than the marketplace for services offered to accountants. As you think about your business model, you might want to determine how you could reformulate it to command a higher multiple (e.g., multiyear contracts, recurring revenue). 

Magnitude of Revenues 

Obviously, buyers pay more for larger companies than for smaller companies because the larger company has more revenue, more clients, and a larger base from which to grow. This disparity is most noticeable in companies with less than $15 million in revenue. We are, of course, excluding the game-changing companies like Twitter and Facebook! For example, a technology company with $50 million in revenue might command a revenue multiple of three, while a similar company with $5 million in revenue might command a revenue multiple of 1.5. Pre-tax Margin Buyers pay a higher multiple for higher margin (pre-tax profit divided by sales) or cash flow–generating companies. Multiples of EBITDA are more commonly used for companies that are generating cash flow on an ongoing basis. Revenue multiples are useful for smaller companies and earlystage companies that have not yet generated positive cash flow.